Lecture 3

READING MATERIAL

• Sloman
– Ch.2 pp. 30-36, Ch.4 pp. 87-97 (material on
marginal utility optional).
Wants and Demand DEMAND

Wants are unlimited

Demand is constrained by income levels

While we might all want to fly to the moon, most of us do not

have sufficient income and therefore our effective demand for
moon flights is zero.
The Law of Demand DEMAND
there is typically an inverse relationship between the price of a
product and the quantity of that product demanded
graphically it is represented by a downward sloping D-curve

Demand Curve for X

Price of X

£100

£20

D-curve

3 8

Quantity of X Demanded
Why is a demand curveDEMAND
downward sloping ?

Three reasons:

• real income effect of a price change

• substitution effect of a price change

• law of diminishing marginal utility

Real Income Effect

• an increase in the price of X, reduces the real income

(purchasing power) of consumers whom have fixed money
income
• consumers cannot buy as many goods and services with
the same money income and therefore quantity demand
contracts
 DEMAND

Substitution Effect

• an increase in the price of X, assuming the price of all other

products remains constant, will make X relatively more
expensive than substitute products for X

• Consumers will switch from X to substitutes and therefore

there will be a contraction in demand for X

• For example:
If the price of butter increase, and the price of
margarine remains constant, people will switch from
butter to margarine
 UTILITY
Law of diminishing marginal utility

Utility is the amount of satisfaction a consumer derives from

consuming a product

Marginal utility is the amount of satisfaction derived from each

additional unit of a product consumed
Coke

Coke

Coke

Coke
1st Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
2nd Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
3rd Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
4th Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
5th Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
6th Drink UTILITY

Recycle
Bin

Satisfaction Metre

Enough OK Very Excellent

Good
Good
 UTILITY
Drink Consumed Satisfaction Metre

1st

2nd

3rd

4th

5th

6th
Enough OK Very Excellent
Good
Good
 UTILITY
Satisfaction Metre Price Prepared Law of Diminishing
To Pay Marginal Utility
Excellent
£1.00
As the quantity consumed
increases, the amount of
Very
satisfaction (utility) derived
Good £0.75 from each additional unit
eventually declines.

Good Therefore the amount one

£0.50
is prepared to pay for each
additional unit will also fall
as the quantity consumed
OK £0.25 increases.

Enough
0 The Law of Demand.
Demand
3rd

6th
4th

5th
2nd
1st

Drink Consumed
 THE LAW OF DEMAND
Demand Curve
Price
£1.00

There is an inverse
relationship between the
price of a Product and the £0.75
Quantity demanded.

OR …. £0.50

Since the satisfaction

derived from each
£0.25
additional unit diminishes,
the price consumers are
prepared to pay is less for
each additional unit. 0 1 2 3 4 5 6
Qty Consumed (Cans)
 Demand Schedule THE LAW OF DEMAND
Q P TR =
Demand equation: A 0 24 0
P = 24 – 4Q B 1 20 20
De m and & Re ve nue C 2 16 32
D 3 12 36
40
36
E 4 8 32
32 F 5 4 20
28 G 6 0 0
Price & Revenue (£)

24
20
A
16 B
12 C
8
D
4
E
0
0 1 2 3 4 5 6 F
Qua ntity G
 Total Revenue (TR) = P x Q THE LAW OF DEMAND
Q P TR = P
Demand equation: A 0 24 0
P = 24 – 4Q B 1 20 20
So TR = PxQ = 24Q – 4Q2 Demand & Revenue
C 2 16 32
D 3 12 36
40
36
E 4 8 32
32 F 5 4 20
28 G 6 0 0
Price & Revenue (£)

24

20
16

12
8 TR

4
0 D-Curve
0 1 2 3 4 5 6
Quantity